MONDAY MORNING RISK MONITOR: YIELD CURVE AND CHINESE STEEL

Key Takeaways

* European bank swaps were a mixed batch last week. German, Spanish, and French banks saw broad tightening last week while Italian and Greek banks widened. Sovereign swaps moved alongside bank swaps this week with most European countries tightening except for Ireland. US Bank swaps were generally uneventful last week.

* Chinese steel prices dropped sharply last week. We use this indicator as a proxy for the health of China's construction industry.

* The yield curve continues to flatten. How low can the 10-year go? More margin pressure to come in 3Q on the heels of sharp 2Q drops in NIM for JPM (-14 bps) and C (-9 bps).

*XLF Macro Quantitative Setup – More downside than upside. Our Macro team’s quantitative setup in the XLF shows 1.1% upside to TREND resistance of $14.87 and 2.7% downside to TRADE support at $14.31.

9. Euribor-OIS spread – The Euribor-OIS spread tightened by 3 bps to 38 bps. The Euribor-OIS spread (the difference between the euro interbank lending rate and overnight indexed swaps) measures bank counterparty risk in the Eurozone. The OIS is analogous to the effective Fed Funds rate in the United States. Banks lending at the OIS do not swap principal, so counterparty risk in the OIS is minimal. By contrast, the Euribor rate is the rate offered for unsecured interbank lending. Thus, the spread between the two isolates counterparty risk.

10. ECB Liquidity Recourse to the Deposit Facility – This index fell sharply from precipitous heights on the first day that the new 0.00% deposit rate went into effect. The ECB Liquidity Recourse to the Deposit Facility measures banks’ overnight deposits with the ECB. Taken in conjunction with excess reserves, the ECB deposit facility measures excess liquidity in the Euro banking system. An increase in this metric shows that banks are borrowing from the ECB. In other words, the deposit facility measures one element of the ECB response to the crisis.

11. Markit MCDX Index Monitor – Municipal spreads tightened 1 basis point last week, ending at 158 bps. Given the spate of bankruptcies in the last few weeks, we're suprised the MCDX is as benign as it is. The Markit MCDX is a measure of municipal credit default swaps. We believe this index is a useful indicator of pressure in state and local governments. Markit publishes index values daily on six 5-year tenor baskets including 50 reference entities each. Each basket includes a diversified pool of revenue and GO bonds from a broad array of states. We track the 16-V1.

12. Chinese Steel -Steel prices in China fell 2.19% last week, or 88 yuan/ton, to 3,928 yuan/ton. Notably, Chinese steel rebar prices have been generally moving lower since August of last year. We use Chinese steel rebar prices to gauge Chinese construction activity, and, by extension, the health of the Chinese economy. We look at the average Chinese rebar spot price.

13. 2-10 Spread – Last week the 2-10 spread tightened to 124 bps, 3 bps tighter than a week ago. While admittedly imperfect, we think this is a useful reference for bank margin pressure.

NYSE Margin debt fell in May to $279 billion from $298 billion in April. We like to to look at margin debt levels as a broad contrarian sentiment indicator. For reference, our approach is to look at it margin debt levels in standard deviation terms over the period 1. Our analysis shows that when margin debt gets to +1.5 standard deviations or greater, as it did in April of 2011, it has historically been a signal of extreme risk in the equity market. The preceding two instances were followed by the equity market losing roughly half its value. Overall this setup represents a long-term headwind for the market. One limitation of this series is that it is reported on a lag.

The chart shows data through May.

Joshua Steiner, CFA

Robert Belsky

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07/16/12 08:55 AM EDT

JULY KNAPP TRACK

The Knapp Track numbers for June suggest a slight sequential improvement in casual dining trends from May. Timing related to 4th of July celebrations inflated the number, however, as the estimate (based on weekly data) takes into account the last week in June which includes July 1. When the account results are released for June, Knapp says, the difference between the estimate based on weekly data and the accounting month will be +0.4-0.6%. Tellingly, traffic trends continue to decline.

Calendar Shift

Knapp noted that the estimates for June were based on weekly data, which included July 1st. Last year, many cities and towns held firework displays to celebrate the 4th of July on Saturday (7/1/11), which lowered casual dining sales. This year, celebrations were held primarily on the 4th, a Wednesday. This shift boosted Knapp Track estimated casual dining comparable restaurant sales growth because the data is based on weekly results and the last week in June included July 1 this year, a week which showed a large increase in sales.

Results

Estimated Knapp Track casual dining comparable restaurant sales grew 1.1 % in June versus an estimated -1.3% in May. The sequential change, in terms of the two year average trend, was +150 bps. However, if we assume the accounting number for May will be in line with the estimate, and the accounting number for June will be 40-60 bps below the estimate (as Knapp suggests it might be), the two year average trend will likely be closer to +125 bps.

Estimated Knapp Track casual dining guest counts declined -1.2% in June versus an estimated -3.9% in May. The sequential change from May to June, in terms of the two-year average trend, was +165 bps. Even with the benefit of a strong last week, which included July 1st, traffic trends continued to decline in June. With the pricing environment as competitive as ever within the space, and within the food retail industry more broadly, restaurant companies are under intense pressure to operate efficiently.

Howard Penney

Managing Director

Rory Green

Analyst

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07/16/12 08:17 AM EDT

THE M3: Q2 TABLES; PARCEL 3; S'PORE NEW HOME SALES; TPI

The Macau Metro Monitor, July 16, 2012

TABLES/SLOTS DSEC

At the end of Q2 2012, Macau had 5,498 (+256 QoQ) gaming tables and 17,035 (+933 QoQ) slots.

SANDS CHINA GETS DEADLINE EXTENSION FOR PARCEL THREE Macau Business

Sands China said it has received an extension of the deadline for the completion of the development of parcel three, in Cotai. The company said it received a letter from the Macau government dated July 13 informing it that a decision had been made by the Secretary for Transportation and Public Works, authorizing the extension of the construction period relating to parcel three until April 17, 2016 (original deadline: April 2013). The government will later notify Sands China of the extension penalty.

Sands China also says parcel three “will target the mass-family market, and will feature family-oriented facilities.” The company says design details for the property are currently being finalized.

NEW PRIVATE HOME SALES FALL 19.4% IN JUNE Channel News Asia

According to Urban Redevelopment Authority, the number of new private homes sold in June continued to fall for the second consecutive month. Developers sold 1,371 private homes (excluding executive condominiums) in June, down 19.4% from May when 1,702 units were sold.

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EURO – failed to hold Friday’s no-volume gains and is also failing to hold the 2010 closing lows; the Euro could go a lot lower; and the USD a lot higher (see our Q3 Macro Theme slides for the update on why); refreshed risk range for EUR/USD = 1.20-1.23

EUROPEAN MARKETS

ASIAN MARKETS

CHINA – Friday’s no-volume USA rally on the lowest consumer confidence print in 7 months was based partly on a rumor China was going to cut again this weekend – but they didn’t, and Chinese stocks got cut to fresh YTD lows, down another -1.7% after Wen said that it needs to be “clearly understood” that #GrowthSlowing is accelerating on the downside.

MIDDLE EAST

ISRAEL – jumping off my risk factoring page this morning for reasons I am not sure of (down -0.6% testing new lows at -3.2% YTD) with plenty of rumoring by the British on possible “attacks” (Iran); something to think about re Oil (+3.1% last wk) keeping a bid during the USD’s recent upswing; middle east tension has been out of the mainline news for a while now.

The Hedgeye Macro Team

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07/16/12 08:00 AM EDT

Hailing Patriotism

This note was originally published
at 8am on July 02, 2012.
INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK
(published by 8am every trading day)
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“I only regret that I have but one life to lose for my country.”

-Nathan Hale

The quote above from Nathan Hale is by many thought to be one of the more patriotic statements made in American history. These words were spoken by Hale shortly before being hung by the British for spying. The 21-year old Yale graduate had been captured by the British after volunteering to go behind enemy lines to report on British troop movement during the Battle of Long Island. Clearly, a willingness to sacrifice your life for your country is the ultimate sacrifice.

Yesterday was Canada Day in Canada and Wednesday will be Independence Day in the United States. While most of us won’t be swearing to give our lives for our respective countries this week, for many of us our patriotism will nonetheless be on display. In many ways, patriotism is a great thing. On the other hand, extreme patriotism is in many instances the root of the more significant military conflicts in modern history. Ultimately at the root of patriotism is a deep seated perspective that your nation’s interests should come ahead of another nation’s interests.

The global equity markets have rallied aggressively over the last couple of days based on perceived positive developments from the European Union summit last week. This is the 20th summit since the European sovereign debt crisis began in 2010 and the ensuing storyline has become somewhat predictable. The leaders of the European Union meet, stories are linked about the possible bailout plans that are in the works, numerous MOUs are signed or agreed to at the end of the summit, and then the markets rally in anticipation of the end of the crisis. Eventually, though, market participants again realize there is no solution and that crisis is far from over. But who knows, perhaps this summit truly was different. Personally, I remain a skeptic.

The ultimate solution in Europe must come from a broad willingness for nations to give up sovereignty on fiscal and budgetary matters. As discussed above, national pride and patriotism run deep, particularly in Europe, therefore relinquishing even some sovereignty for collective fiscal and budgetary decisions will not be an easy matter. So, even if the headlines coming out of the most recent summit are positive, we need to keep in mind that any actual implementation of a broad based solution will not be simple, or quick.

On the economic data front, the Purchasing Managers Index for manufacturing in Europe came out this morning at 45.1. This is the 11th monthly decline and the rate of decline was comparable to that of May, which was the fastest monthly decline in almost three years. Overall, the average reading of 45.4 was the slowest reading since Q2 2009. Most disturbing is likely the fact that Germany is clearly no longer immune from growth headwinds as German PMI came in at 45.0 for the fourth consecutive month of declines. All in all, pretty somber news as it relates to growth, or lack thereof.

The larger emerging issue from Europe’s structural growth problem is that of unemployment. In May, the Eurozone unemployment rate came in at a new record of 11.1% with more than 17 million people unemployed in the 17-nation Eurozone. Consistent with its victory in the European Cup over the weekend, Spain continues to also lead on the unemployment front with unemployment at 24.6%, though is followed closely by Greece at 21.9% and Portugal at 15.2%. There is no question given the current state of the European Union, as most recently indicated by the PMI numbers outlined above, that we have not yet seen highs in unemployment.

Later this week both the European Central Bank and the Bank of England will meet and then give their most recent rate decisions. Similar to the Federal Reserve, both of these central banks are largely out of bullets. It is expected that both banks will cut rates by 25 basis points and approve a 50 billion pound bump in the asset purchase program, respectively. Based on the move we’ve seen in European equities and bonds in the last few days, it seems likely that even coming in line with expectations may actually be a disappointment.

We continue to be very conservatively positioned in both the Hedgeye Asset Allocation Model with 91% cash and in the Hedgeye Virtual Portfolio that now has 5 longs and nine shorts. So, yes, we are now running net short in the Virtual Portfolio as Keith added the following shorts in Friday’s melt up: Discover Financial Services (DFS), Italian equities (via the etf EWI), the Russell 2000 (via the etf IWM), and Brent Oil (via the etf BNO).

As you head into July 4th and celebrate American independence with your friends and family, and despite some of the somber economic news coming out of Europe, it is important to remain optimistic and upbeat. As such, I’d like to leave you with quotes from two American Presidents, a Republican and a Democratic. They are as follows:

“There is nothing wrong with America that cannot be cured with what is right about America.”

-President Bill Clinton

“America has never been an empire. We may be the only great power in history that had the chance, and refused – preferring greatness to power and justice to glory.”

-President George W. Bush

Our immediate-term support and resistance ranges for Gold, Oil (Brent), US Dollar, EUR/USD, Germany’s DAX, and the SP500 are now $1583-1623, $92.82-97.66, $81.21-82.16, $1.25-1.27, 6269-6563, and 1336-1365, respectively.

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